Solve the Proposition 13 problem by paying off the difference when you sell

Even if you are not in California, you may have heard of Proposition 13 the ballot measure which changed property tax rules.

It was part of a tax revolt, and it changed how the value of your real estate is calculated for property taxes. As California property started zooming up in price, there were people who owned homes but had minimal incomes. They were facing growing tax bills even though they had not realized the gains on their house. Some were being forced out of houses they had lived in for decades, the story went.

The solution was that while you lived in your home, the tax value would go up at 2% a year, nothing like the real market value. Taxes were limitd to 1% of value.

There have been many criticisms of Prop 13, in particular over how it has seriously reduced local tax income for counties and cities, which is the prime source for funding schools. The bigger problem, I find is the massive inequality it causes. If you buy a home today, you pay tax on its full price. You can afford it, they figure. This means that two people living next to one another in two identical houses pay massively different taxes. My neighbour, who inherited her home from her parents, pays next to nothing. I, who have lived in my home for many years, pay half of what new neighbours pay.

Taxation should not be so different among the same people. In addition, this creates a "moving disincentive." If I decide to sell my house and buy one of equal value, my tax rate will jump a lot. (There is a once-per-lifetime exemption for seniors who "downgrade" their home within a set of counties.)

Nobody seems to know how to fix it because if you try to even out the tax rates, you will cause massive problems for the people who have come to depend on the artificially low rates they have compared to their neighbours. They really will get forced from their homes.

My solution -- let people defer the extra tax as debt

My proposal is fairly straightforward. As in the rest of the world, properties would be assessed and taxed on their market value. However, homeowners could elect to pay less tax, paying as little as the "floor" set under Prop 13 -- the value of their house when they paid for it, appreciating 2% per year.

Any difference would be recorded as a debt on the properly to the county. Interest would also be accrued on the debt. It would only come due when the house is sold, or on certain estate transfers.

In other words, you can pay the market value tax, or you can pay the lower Prop 13 tax. If you pay the lower tax, you accumulate a big pile of debt that comes due when you sell and realize the gain. As such, a chunk of your gain will now go to pay off the taxes you didn't pay, plus interest.

This solves most of the problems.

Nobody is forced out of their home by growing taxes.

Counties get all their tax revenue, but much of it is deferred. Since it comes with interest, that's workable though may not give them the best cash flow. (It's better than what they have now.)

Everybody is treated the same -- nobody gets a windfall by having been in their house for a long time

Most of the barrier to moving is removed. (Though not all because it does change cash flow.)

In theory, once counties adjust, they could probably even lower tax rates for most people because of the much higher collection they are now getting. In theory; we don't usually see them lower taxes.

Counties could issue tax free municipal bonds to fix their cash-flow problem, secured by the liens on all those houses. They might have precedence against the mortgage, but it should not matter, as these houses are all highly appreciated. (Some would argue it should have 2nd preference, or banks might loan less and depress housing prices. In the end a tax increase will have a modest negative effect on housing prices.)

The tax you don't pay could be a deduction in the year you "owe" it because in theory you paid it, and then took out a loan to provide the cash. Alternately, the total debt could offset the capital gain when you sell if you prefer, making it closer to today's situation, just with less gain.

Alternative

House prices sometimes fall. One alternative would be to only calculate the final tax bill upon sale of the home. If the home actually went down on sale, there would be no extra tax burden -- but probably no refund. If the home went up-up-up and then down, tax might be calculated on some simple formula as though it rose at a constant rate to the sale price. This has the advantage that the county does not have to assess value. This reflects the generally good principle that you don't pay tax on unrealized gains, which is one of the problems people had with Prop13.

Commercial real estate

Many have noted a loophole with Prop13 on commercial real estate. In many cases it never changes hands, because it is owned by a holding company. To buy the building you buy the holding company. It might be simple -- though far from easy due to opposition from the rich commercial real estate holders -- to have sale of the holding company count as a sale. In addition, there could be some cap on the lifetime of a commercial holding, so that a company has to declare a readjustment some time before 20 years. They can pick the date. It does require an assessor.

Could this sell?

This is much more fair, but we longtime landowners obviously would still not like to vote for it because we would start racking up this debt. As such, it might be sweetened by requiring counties to adjust their tax rates to make it revenue neutral to start, which would bring in the votes of those paying very high taxes today.

Or could people even support it as the right thing to do, to get more money for schools and local services? I benefit greatly from Prop13 but would support it (if I could vote...)

Comments

I understand why governments use property value to asses taxes. It allows them to have some basis of comparison. I don't understand why they aren't cutting the tax rate as property values grow. If it costs $10,000 for the municipality to service a home today, and the value of the home doubles in value over some short time, the government shouldn't need to double the taxes collected to $20,000. That home isn't producing more trash, sewage, or children to educate. If the population is growing, then there should be more homes being built that will add additional tax revenue to account for building more roads and schools. This smells of poor management of public resources.

First of course, there is inflation. Home prices go up with that and of course often more than that, which is what you're asking about. As a town gets more expensive (above inflation) people come to expect more from it. Better schools in particular, which is the main thing funded with these taxes. In fact, the problem with prop13 is that we have expensive towns taxed like they are cheap towns, and thus they have the schools of cheap towns. That's one thing people want to fix. Actually, at least where I live, I pay for trash and sewage, property taxes don't go for that. They do go for fire/cops/schools/parks etc.

Actually, the situation with taxes and school funding in CA isn't quite as simple as expensive towns with well funded schools vs cheap towns with poorly funded schools -- there's some rebalancing at the state level intended to address that inequality, albeit imperfectly. See Serrano v. Priest. Though with schools across the state resorting to fund drives to make ends meet, it's inevitable that the schools in the rich districts will end up richer.

Indeed, this happens. The central point however, is, whatever tax rate the county should get, I believe it should be applied evenly. Two neighbours with similar houses should not pay vastly different taxes just because one has sat in their home and one has traded homes a couple of times. Vastly different.

I understand why Prop13 came in to create this inequality. The longtime homeowner might be house poor and people wanted to protect them. But they are just as likely to not be house poor. The home trader is less likely, but they are much more likely to be underwater and get foreclosed on. My proposal protects the house poor from losing their homes over rising taxes, so the motivation for the inequality goes away.

Prop13 effectively has become a major disincentive to moving. I see no reason why we want to go so far to discourage moving.

Oh, I agree completely about your main point. Beyond the problems of inequality and underfunded schools/services, I also think it's a bad thing in general for property taxes to be too low. Property taxes discourage holding on to real estate without putting it to productive use. I count "living in" as productive, since it provides value to the person living there. As you note, Prop 13 actually discourages people from selling to move to a new house. It also encourages hoarding and not renovating buildings that have been owned for a long time (since renovation triggers reappraisal). So you end up with empty, derelict buildings in the midst of a severe housing shortage.

Something like this already exists in Massachusetts: "Residents 65 years or older can defer all or a portion of their taxes at a rate of 5% interest. In order to qualify residents must have lived in MASS for the past ten years and owned/occupied their home for the last five years. Gross annual income must not exceed $40,000. This a a program that not many people are aware of."
http://massrealestatenews.com/massachusetts-property-tax-relief-for-seniors/

Apparently Palo Alto voted against Prop 13. It was also unusual in having a tax rate set by dividing the city budget by the total city property value; so when property prices went up, Palo Alto taxes only went up by the change in the city expenditures.

I wonder why more cities don't adopt this method of determining tax rates.

quote: "...having a tax rate set by dividing the city budget by the total city property value"

And if that doesn't generate enough $$$, the city simply raises the assessed value. In many places (most places?) the city's assessed value of a parcel isn't required to equal, reflect, or in any way resemble actual true market value.

My thought is that property tax valuations should always be set at a value at which the property owner can demand the taxing entity purchase the property. this will ensure that valuations are sufficiently to so as to not be challenged. Tax revenue would be achieved by setting the tax rate at the level necessary and in full public view through democratic processes as opposed to valuations which are individual and set through arbitrary processes.

I've been advocating for this idea on Hacker News for some time (including in the discussion of this post. I strongly believe that this is how Prop. 13 should have been structured to begin with. (It should also have applied only to owner-occupied primary residences, not to rental or commercial property). It's great to see a blogger picking up on it.

An objection that's been raised frequently is, what happens if the value of the lien becomes so large as to make it uneconomical to sell the property? Actually this is almost impossible; the only way for the lien to get large is for property values to go up a lot for a long time, at which point the gain from selling the property is easily enough to cover the lien. But, this is a slightly complex mathematical argument, and my experience has been that some people just don't get it. To make them feel better, I propose the following limitation: when the property is sold, if the lien is larger than half the gain on the sale, the difference will be forgiven; that is, the amount the seller will have to pay on the lien will never be more than half of their gain, and will be zero if the property is sold at a loss (there won't be a refund in that case, though).

I don't expect this provision to kick in very often if ever, but if it helps overcome people's objections, it's worth including.

I would also suggest that the interest rate should be kept low, on the order of the T-bill rate. Even if it's zero, localities will come out better under this proposal than they do now.

An acquaintance of mine bought a house in Palo Alto many years ago. It was so long ago that the record doesn't show up on Zillow, but just for example, he might have bought it in 1983 for $250k. Anyway, Zillow now has it listed for $3.3M, and he thinks he could get $4M. That's at least a $3M gain! Why shouldn't Palo Alto get, say, 10% of that? I think the people who say "please leave Prop. 13 alone" are not seeing this reality — massive amounts of money are being sucked out of our communities by people who happened to be lucky enough to buy property at a good time. Some of these gains should go to support schools and city services!

I propose another solution, which is the back tax is only calculated at sale, presuming the properly appreciated in a standard continuous way, no ups, no downs. If the property net went down, there is no extra tax.

Instead of the community relying on a tax that can grow to any figure as a percentage of the property value, implement a fixed banded tax (still based on the property value but with a maximum band) that generates the requirement for local services which can be adjust slightly each year as necessary. Then, upon sale of the property, collect another tax. Essentially what the UK does; council tax and stamp duty.